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41 CHAPTER 3 EXOGENOUS and ENDOGENOUS GROWTH Neo-Classical Theory, in All Its Forms, Shows a Strong Tendency to Reduce the Econo

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41 CHAPTER 3 EXOGENOUS and ENDOGENOUS GROWTH Neo-Classical Theory, in All Its Forms, Shows a Strong Tendency to Reduce the Econo 41 University of Pretoria etd - De Jager, JLW (2004) CHAPTER 3 EXOGENOUS AND ENDOGENOUS GROWTH Neo-classical theory, in all its forms, shows a strong tendency to reduce the economic complexity of the analysis, doing so by holding the institutional framework constant. Choi (1983:33) 3.1 INTRODUCTION In terms of the initial neoclassical theory described by Solow (1956) and augmented by others, sustained economic growth occurs through an exogenous factor of production, that is, the passage of time. The neoclassical production function used in this theory relates output to factor inputs, which consist of the stock of accumulated physical capital goods (buildings, machinery, transport equipment, computers, and so on) and labour, which is regarded as only one type. The theory imposes decreasing returns with respect to the use of each (reproducible) factor of production (and constant returns overall). From these assumptions it follows that an increase in the stock of capital goods will result in a less than proportionate increase in output, provided the amount of labour employed stays the same (Van der Ploeg and Tang 1992:15). Eventually more capital stock will produce no more output, resulting in lower profits, and for this reason output growth cease. If new technologies improve the productivity of labour and of capital and so prevent a decrease in the rate of return on investment, the labour force will grow at an exogenous rate. The growth of output is accordingly related to the amount and quality of the stocks of production factors. That part of output growth that cannot be explained by the growth in production factors is often called the Solow residual by economic researchers and/or total factor productivity in applied work. The calculation of total factor productivity assumes perfect competition in labour and capital markets, but also in product and 42 University of Pretoria etd - De Jager, JLW (2004) service markets. This assumption allows the calculation of multifactor inputs by weighing labour and capital input increases in terms of their national income shares (remuneration of employees and gross operating surplus respectively). This joint factor contribution to output is usually substantially less than the growth in output. This unexplained part of output growth is often called the Solow residual, which he termed the “measure of our ignorance”. This is a rather ambiguous phrase, because it refers to the nebulous knowledge of economists on the matter, but signifies improvement in the knowledge base of the workforce in general. The labour force grows in accordance with population growth and is augmented by technical progress, both exogenously determined. Eventually capital, output and consumption will also grow at this exogenous rate and converge to an equilibrium growth path. Accumulation of capital in exogenous growth theory is a vehicle for ongoing technical development. Neoclassical theory gives no economic explanation for such development, but instead includes a time trend (usually representing technical progress) in the model for the long-run rate of economic growth. The exogenous technical progress assumed in the older versions of growth theory limits the explanation of the growth process. When the standard Solow model is used with real data in order to explain adjustment to balanced growth paths, predictions for the speed of convergence and the capital income share in national income are generally too high. 3.2 KALDOR’S STYLISED FACTS Stylised facts are “broad generalizations that are true in essence, though not always in detail” (Bannock 1998:396). Bannock states: “this is one of the most important, but least acknowledged forms of empirical testing in economics…. Many models are designed simply to explain behaviour at its simplest, and can be judged only against the broad truth, rather than the detail”. 43 University of Pretoria etd - De Jager, JLW (2004) The broad facts about the growth of advanced industrial economies, which a well-specified growth model should be able to explain, are summed up in Kaldor’s (1961:178-179) “stylised facts”. Solow (1970:2) agrees with the stylised label, but casts doubt on the factual claim. He nevertheless concedes that “they are what most of the theory of economic growth actually explains”. The exogenous technical progress of the neoclassical theory fits into Kaldor's stylised facts (Van der Ploeg and Tang 1992:16). Kaldor’s (1961:178-179) “stylised facts” are as follows: • continued growth in the aggregate volume of production and in labour productivity; • continued increase in the amount of capital per worker, over fairly long periods; • a steady rate of profit on capital; • a steady capital-output ratio over long periods (this is contested by Jorgensen and Grilliches (1967:265-267) who pointed out short-term cyclical variations and that one should rather use flows of capital services instead of capital stocks. Solow (1970:3) pointed out that capital and output could vary substantially as a result of shift work, downtime and running speed); • economies with a high share of profits in income tend to have a high ratio of investment to output; • appreciable differences in the rate of growth of labour productivity and total output in different societies. Solow (1970:3) is less interested in the latter two facts “because they relate more to comparisons between different economies than to the course of events within one economy”. The statement could relate to the fact that international comparisons in the form of cross-country analyses requiring internationally comparable data are a rather recent event, dating to the ground-breaking work of Summers and Heston (1991, 1988) in the late1980s and early 1990s. Although many of these facts feature in the neoclassical theory, Kaldor (1961:179) maintains that “none of these ‘facts’ can plausibly be ‘explained’ by the theoretical constructions of neoclassical theory”. For example, according to the neoclassical marginal productivity theory, one should expect a 44 University of Pretoria etd - De Jager, JLW (2004) continued fall in the rate of profit with capital accumulation, not a steady rate of profit. Kaldor's purpose is therefore to present a model of income distribution and capital accumulation that is capable of explaining at least some of the above stylised facts (Choi 1983:44-45). Kaldor (1978b:76) makes use of a virtuous growth spiral involving cumulative causation that was often used by Myrdal (1957:11-16), and the concept of increasing returns described by Allyn Young (1928:2). With the concept of the virtuous spiral and cumulative causation, success breeds success whereas failure begets more failure. Kaldor constructed a two-sector model as a tool to explain the differences in growth rates as well as the seemingly permanent gaps in growth rates among different economies and regions in a country. 3.3 STYLISED FACTS USED BY OTHER RESEARCHERS Some contemporary researchers refer to Kaldor's stylised facts and amend the original six facts for their purposes or create entirely new ones. Boltho and Holtham (1992:2) are two researchers who followed the tradition of borrowing from Kaldor but also collecting and creating their own facts. The following are their stylised questions (facts), which they contend a useful model should be able to explain: • Why have countries, or groups of countries, been able to grow for decades in succession with no apparent tendency to slow down, despite rising capital-labour ratios? • Why has convergence in per capita incomes across the world seemingly failed to materialise? • Why have countries or groups of countries generally exhibited medium- to long-term accelerations or decelerations in their growth? (Also see Van der Ploeg and Tang 1992:21.) Romer (1989b:54) quotes Kaldor’s stylised facts and agrees with Kaldor’s idea that these broad tendencies are essential in the conceptual stages of a body of theory. He is of the opinion that without stylized facts to aim at, “theorists would be shooting in the dark”. Romer paraphrased Kaldor’s stylized as follows: 45 University of Pretoria etd - De Jager, JLW (2004) • Wide differences are observed in growth rates of productivity between countries; • There is no apparent tendency for productivity growth rates to decline over time; • Capital per worker seems to grow continuously; • The capital/output ratio is steady; • The rate of return on capital is steady; • The shares of capital and labour in the total income remains virtually constant; Romer (1989b:55) is of the opinion that the basic questions about growth need to be re-examined. He then extends Kaldor’s stylized facts to “make sure not only that the facts have some connection with measured data but also that the list be as inclusive as possible”. He augments the original facts by observing that there are five other prominent features that characterise economic data: • There appears to be no correlation between the mean growth rate and the level of output per head in cross section analyses • The contribution of measurable factor inputs leaves a substantial residual in growth accounting; • Growth in trade volumes are positively correlated with the level of income; • Population growth rates show a negative correlation with the level of income; • Both skilled and unskilled workers tend to migrate to high income countries. Easterly and Levine (2000:1) produced the following stylised facts of economic growth: • The “residual” rather than factor accumulation accounts for most of the income and growth differences across nations; • Income diverges in the long run; • Factor accumulation is persistent whereas growth is not persistent; • Economic activity is highly concentrated, with all factors of production flowing to the richest areas; • National policies exert a considerable influence on long-run economic growth rates. 46 University of Pretoria etd - De Jager, JLW (2004) Easterly and Levine (2000:37) suggest that these facts are more consistent with a technology explanation of growth and income differences than a factor accumulation explanation.
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